RUSSIA

Cautious and well-tuned economic policies have provided some cushion against the new sanctions that have been imposed against Russia since 2018 and should continue to do so in the near term. These include monetary policy credibility, diligent fiscal policy and export diversification. Furthermore, the Russian government is pursuing the de-dollarization of the economy – a multi-year drive to reduce exposure to US assets pushed the share of gold in the Central Bank of Russia’s total international reserves above the USD share for the first time on record. In June 2020, gold accounted for 23% of the reserves while the share of USD assets had fallen to 22% from more than 40% in 2018. A reduced dependence on the USD lowers the vulnerability to external shocks.

Monetary policy to remain well-tuned and credible

In the aftermath of the currency crisis and the resulting surge in inflation in 2014-2015, the Central Bank of Russia (CBR) embarked on a credible inflation targeting regime under Governor Elvira Nabiullina. Monetary policy was gradually eased in line with falling inflation until mid-2018. When inflation expectations began to rise again due to the anticipated VAT hike in 2019, policy interest rates were pre-emptively hiked from September 2018. Then, in June 2019, the CBR changed course again and cut its key policy interest rate by a cumulative 150bp to 6.25% in December 2019, citing slowing inflation and the weak economic momentum in most of 2019. Monetary easing was continued in 2020 in order to mitigate the impact of the Covid-19 crisis on the economy. The policy rate was cut by another cumulative 200bp to 4.25%.

Crucially, the policy rate remained above the inflation rate until October 2020. Thereafter it picked up to 5.2% y/y in January 2021, in part due to a strong increase in volatile food prices. This has reduced the chance of an interest rate cut in 2021. However, the CBR should also not overreact and hike rates since we expect headline inflation to fall back to around 4% by the end of the year.

Governor Nabiullina has also shut down many non-viable banks, though more needs to be done on this end. Overall, the CBR continues to enjoy a high degree of independence and credibility, especially as compared to peer countries.

Nonetheless, currency risk remains on the agenda, although an equally steep RUB depreciation as in 2015 (-59% vs. the USD on average) is highly unlikely until end-2020. But after rebounding by +13% in 2017, the RUB experienced volatility again and lost on average -8% in 2018, -3% in 2019 and -10% in 2020, mainly responding to sharp oil price moves or disturbing political events, including new sanctions.

Fiscal prudence has been relaxed but not abandoned

Fiscal policy has been diligent in Russia in recent years. In the wake of the currency crisis and recession in 2015-2016, Russian authorities have prioritized financial stability over economic growth. Public spending growth was modest in 2017-2019 (average annual +2.1%) before picking up to +4% in 2020 due to some stimulus to mitigate the impact of the Covid-19 crisis. Yet, government expenditure in Russia is still fairly moderate as compared to other countries, accounting for around 35% of GDP. This is, for example, similar to the ratio in China but lower than that in South Africa (39%), Poland (41%) and Hungary (47%), as well as the EU average (46%). At the start of 2019, the government increased the VAT rate from 18% to 20%, a step in the right direction in order to diversify its fiscal income base and reduce its vulnerability to global commodity prices.

However, the Russian government had also announced a set of so-called National Projects, an investment program estimated at RUB25tn (about USD400bn) running from 2019-2024. The aim was to boost growth and living standards, which have suffered markedly since the 2015-2016 crisis. But this program did not really take off in 2019 and suffered a setback in 2020 due to the crisis. It remains to be seen whether this program will gain traction again, but we expect at least some fiscal stimulus with positive growth effects to come, especially as there will be legislative elections in 2021.

After two years of annual surpluses, Russia’s fiscal balance shifted into an estimated deficit of -4.7% of GDP in 2020 in the wake of Covid-19. We forecast further but smaller deficits of -2% in 2021 and -1.3% in 2021. Overall public debt will increase from 14% of GDP in 2019 to a projected 20% at the end of 2021, but this will still be a relatively low ratio compared to Emerging Market peers.